|
|
 | | | |
- close
- close
- close
- close
L Brands, Inc. 8-K 2009 Exhibit 99.1
1
The cumulative effect of adopting SFAS 123(R) was $0.7 million, net of tax of $0.4 million, and was recognized as an increase to net income in the Consolidated Statement of Income as of the beginning of the first quarter of 2006.
The cumulative effect of this change was $17 million, net of tax of $11 million. This change was recognized as an increase to net income in the Consolidated Statement of Income as of the beginning of the first quarter of 2005. In addition to the $17 million cumulative impact recognized as of the beginning of the first quarter, the effect of the change during 2005 was to decrease net income by $4 million, or $0.01 per diluted share.
For additional information on 2008, 2007 and 2006 items, see the Notes to the Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data.
For additional information on 2008 and 2007 items, see the Notes to the Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data.
2
The following discussion and analysis of financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The following information should be read in conjunction with our financial statements and the related notes included in Item 8. Financial Statements and Supplementary Data. Our operating results are generally impacted by changes in the U.S. and Canadian economies and, therefore, we monitor the retail environment using, among other things, certain key industry performance indicators such as the University of Michigan Consumer Sentiment Index (which measures consumers’ views on the future course of the U.S. economy), the National Retail Traffic Index (which measures traffic levels in malls nationwide) and National Retail Sales (which reflects sales volumes of 5,000 businesses as measured by the U.S. Census Bureau). These indices provide insight into consumer spending patterns and shopping behavior in the current retail environment and assist us in assessing our performance as well as the potential impact of industry trends on our future operating results. Additionally, we evaluate a number of key performance indicators including comparable store sales, gross profit, operating income and other performance metrics such as sales per average selling square foot and inventory per selling square foot in assessing our performance. Executive Overview Strategy Our strategy supports and drives our mission to build a family of the world’s best fashion retail brands whose well-told stories create loyal customers and deliver sustained growth for our stakeholders. To execute our strategy, we are focused on these key strategic imperatives:
2008 Overview We anticipated that the retail environment would be challenging in 2008. However, the holiday season was much more difficult than expected as a result of the global economic downturn and its impact on the U.S. and Canadian retail environment. Our financial performance in 2008 was significantly impacted by the downturn. Our net sales decreased 11% to $9.043 billion, driven by a comparable store sales decrease of 9%, and our operating income decreased $521 million to $589 million. The decline in our operating income included a $215 million impairment of goodwill and other intangible assets related to our La Senza business. For additional information related to our 2008 financial performance, see “Results of Operations – 2008 Compared to 2007.” As a result of these challenges, we focused on the conservative management of retail fundamentals including:
3
2009 Outlook Economic Environment The global retail sector and our business continue to face a very uncertain and difficult environment and, as a result, we have taken a defensive stance in terms of the financial management of our business. We will continue to manage our business conservatively and we will focus on the execution of the retail fundamentals noted above. At the same time, we are aggressively focusing on bringing compelling merchandise assortments, marketing and store experiences to our customers. We will look for, and capitalize on, those opportunities available to us in this difficult environment. We believe that our brands, which lead their categories and offer high emotional content at accessible prices, are well positioned heading into 2009. International Expansion We anticipate opening approximately 20 new Bath & Body Works Canada stores in 2009. The six stores that we opened in 2008 have exceeded our performance expectations. Additionally, we will continue to explore other international opportunities in 2009. Capital Expenditures We plan to spend approximately $200 million in 2009 on capital expenditures with the majority relating to opening new stores and remodeling and improving existing stores. We expect to open approximately 50 new stores in the U.S. and Canada and to remodel approximately 40 stores during 2009.
4
Store Data The following table compares 2008 store data to the comparable periods for 2007 and 2006:
5
The following table compares 2008 store data to the comparable periods for 2007 and 2006:
6
Results of Operations – 2008 Compared to 2007 Operating Income The following table provides our segment operating income (loss) and operating income rates (expressed as a percentage of net sales) for 2008 in comparison to 2007:
For 2008, operating income decreased $521 million to $589 million and the operating income rate decreased to 6.5% from 11.0%. The drivers of the operating income results are discussed in the following sections.
7
Net Sales The following table provides net sales for 2008 in comparison to 2007:
The following tables provide a reconciliation of net sales for 2007 to 2008:
The following table compares 2008 comparable store sales to 2007:
8
For 2008, our net sales decreased 11% to $9.043 billion and comparable store sales decreased 9%. The decrease in our net sales was primarily driven by the following: Victoria’s Secret For 2008, net sales remained relatively flat at $5.604 billion and comparable store sales decreased 8%. The net sales result was primarily driven by:
Partially offset by:
The decrease in comparable store sales was primarily driven by declines in store traffic and transactions in addition to decreased units per sales transaction. Bath & Body Works For 2008, net sales decreased 5% to $2.374 billion and comparable store sales decreased 9%. Net sales decreased driven by weak store traffic and the challenging economic environment. From a category perspective, declines in Signature Collection were offset partially by increases in the Aromatherapy, True Blue Spa and home fragrance categories. The decrease in comparable store sales was primarily driven by declines in store traffic and lower average unit retail prices offset partially by an increase in merchandise units per transaction. Apparel and Other For 2008, Apparel net sales decreased $870 million as a result of the 2007 divestitures of 75% of our equity interests in Express and Limited Stores. In addition, Other net sales decreased $98 million to $1.065 billion primarily driven by a decrease in Mast sales as well as the personal care joint venture that was sold in the first quarter of 2008. Gross Profit For 2008, our gross profit decreased 14% to $3.006 billion and our gross profit rate (expressed as a percentage of net sales) decreased to 33.2% from 34.6% primarily driven by the following: Victoria’s Secret For 2008, gross profit decreased primarily driven by the decrease at Victoria’s Secret Stores in net sales and the related decrease in merchandise margin dollars combined with increased buying and occupancy expenses related to our new and remodeled stores. Victoria’s Secret Direct’s gross profit remained relatively flat as the impact of the 9% increase in net sales was offset by the impact of increased promotional activity to clear inventory and an increase in catalogue circulation. The gross profit rate decreased driven primarily by an increase in the buying and occupancy expense rate as cited above. Bath & Body Works For 2008, gross profit decreased primarily driven by lower net sales and a related decrease in merchandise margin dollars combined with an increase in buying and occupancy expenses associated with store real estate activity. The gross profit rate decreased driven primarily by an increase in the buying and occupancy expense rate due to the factors cited above. Apparel and Other For 2008, gross profit decreased $250 million as a result of the divestitures of 75% equity interest in Express and Limited Stores in 2007.
9
General, Administrative and Store Operating Expenses For 2008, our general, administrative and store operating expenses decreased 12% to $2.311 billion primarily driven by:
Partially offset by:
The general, administrative and store operating expense rate decreased to 25.6% from 25.8% primarily driven by the factors cited above. Impairment of Goodwill and Other Intangible Assets In the fourth quarter of 2008, we recognized charges totaling $215 million related to the impairment of goodwill and trade name assets associated with our La Senza business. The impairment charges were based on our evaluation of the estimated fair value of the La Senza business and trade name assets as compared to their respective carrying values. Our evaluation concluded that as a result of the global economic downturn and the related negative impact on La Senza’s operating performance, the fair value of the La Senza business and trade name assets were below their carrying values as of the fourth quarter of 2008. For additional information, see Critical Accounting Policies and Estimates and Note 10 to the Consolidated Financial Statements included in Item 8. Financial Statements and Supplemental Data. Net Gain on Joint Ventures In April 2008, we and our investment partner completed the divestiture of a personal care joint venture to a third party. We recognized a pre-tax gain of $128 million on the divestiture. The pre-tax gain is included in Net Gain on Joint Ventures on the 2008 Consolidated Statement of Income. In addition, we recorded a $19 million impairment charge related to another joint venture. The charge consisted of writing down the investment balance, reserving certain accounts and notes receivable and accruing a contractual liability. The impairment of $19 million is also included in Net Gain on Joint Ventures on the 2008 Consolidated Statement of Income. Apparel Divestitures On July 6, 2007, we finalized the divestiture of a 75% ownership interest in our Express brand to affiliates of Golden Gate Capital for pre-tax net cash proceeds of $547 million. The transaction resulted in a pre-tax gain on divestiture of $302 million. On August 3, 2007, we divested a 75% ownership interest of our Limited Stores business to affiliates of Sun Capital Partners. As part of the transaction, Sun Capital contributed $50 million of equity capital into the business and arranged for a $75 million credit facility. We received no cash proceeds from the transaction and recorded a pre-tax loss of $72 million on the transaction. Other Income and Expenses Interest Expense The following table provides the average daily borrowings and average borrowing rates for 2008 and 2007:
For 2008, interest expense increased $32 million to $181 million. The increase was primarily driven by an increase in average borrowings and an increase in fees related to our credit facilities partially offset by a decrease in the average borrowing rate. Interest Income For 2008, our interest income remained flat at $18 million as the impact of higher average invested cash balances was offset by a decrease in average effective interest rates.
10
Other Income (Loss) For 2008, other income (loss) decreased $105 million to $23 million due to a 2007 gain of $100 million related to a distribution from Easton Town Center, LLC and net gains of $17 million from the settlement of interest rate lock agreements in 2007. The other income decrease was partially offset by a $71 million cash distribution from Express which resulted in a pre-tax gain of $13 million in 2008. Provision for Income Taxes For 2008, our effective tax rate increased to 51.5% from 36.4%. The increase in the rate resulted primarily from the 2008 impairment of goodwill and other intangible assets at La Senza, which is not deductible for income tax purposes. Net Income (Loss) Attributable to Noncontrolling Interest For 2008, net loss attributable to noncontrolling interest decreased $18 million to $4 million. Net income (loss) attributable to noncontrolling interest represents the proportional share of net income or losses of consolidated, less than wholly owned subsidiaries attributable to the noncontrolling investor. The decrease is a result of the divestiture of a personal care joint venture in first quarter of 2008 and the closure of a technology joint venture in December 2007. Results of Operations – Fourth Quarter of 2008 Compared to Fourth Quarter of 2007 Operating Income The following table provides our segment operating income (loss) and operating income rates (expressed as a percentage of net sales) for the fourth quarter of 2008 in comparison to the fourth quarter of 2007:
For the fourth quarter of 2008, operating income decreased $468 million to $153 million and the operating income rate decreased to 5.1% from 19.0%. The drivers of the operating income results are discussed in the following sections.
11
Net Sales The following table provides net sales for the fourth quarter of 2008 in comparison to the fourth quarter of 2007:
The following table provides a reconciliation of net sales for the fourth quarter of 2007 to the fourth quarter of 2008:
The following table compares fourth quarter of 2008 comparable store sales to fourth quarter of 2007:
For the fourth quarter of 2008, our net sales decreased 9% to $2.991 billion and comparable store sales decreased 10%. The decrease in our net sales was primarily driven by the following:
12
Victoria’s Secret For the fourth quarter of 2008, net sales decreased 7% to $1.767 billion and comparable store sales decreased 10%. The decrease in net sales was primarily driven by:
Partially offset by:
The decrease in comparable store sales was primarily driven by declines in store traffic and lower average unit retail prices offset partially by an increase in merchandise units per transaction. Bath & Body Works For the fourth quarter of 2008, net sales decreased 8% to $998 million and comparable store sales decreased 11%. Net sales decreased across most merchandise categories as a result of the challenging economic environment. The decrease in comparable store sales was primarily driven by lower average unit retail prices and declines in store traffic. Other For the fourth quarter of 2008, net sales decreased 25% to $226 million. The decrease in net sales was primarily driven by a decrease in Mast sales as well as the personal care joint venture that was sold in the first quarter of 2008. Gross Profit For the fourth quarter of 2008, our gross profit decreased 21% to $1.024 billion and our gross profit rate (expressed as a percentage of net sales) decreased to 34.3% from 39.6% primarily driven by the following: Victoria’s Secret For the fourth quarter of 2008, gross profit decreased primarily driven by:
The decrease in the gross profit rate was driven primarily by a decrease in the merchandise margin rate and an increase in the buying and occupancy expense rate due to the factors cited above. Bath & Body Works For the fourth quarter of 2008, gross profit decreased primarily driven by lower merchandise margin dollars as a result of a decline in net sales and an increase in promotional activity to drive sales and clear inventory. In addition, buying and occupancy expenses increased as a result of our store real estate activity. The decrease in the gross profit rate was driven by a decrease in the merchandise margin rate and an increase in the buying and occupancy rate due to the factors cited above.
13
General, Administrative and Store Operating Expenses For the fourth quarter of 2008, our general, administrative and store operating expenses decreased 3% to $656 million primarily driven by:
Partially offset by:
The general, administrative and store operating expense rate increased to 21.9% from 20.6% primarily driven by the overall decline in sales during the fourth quarter of 2008. Impairment of Goodwill and Other Intangible Assets In the fourth quarter of 2008, we recognized charges totaling $215 million related to the impairment of goodwill and trade name assets associated with our La Senza business. The impairment charges were based on our evaluation of the estimated fair value of the La Senza business and trade name assets as compared to their respective carrying values. Our evaluation concluded that as a result of the global economic downturn and the related negative impact on La Senza’s operating performance, the fair value of the La Senza business and trade name assets were below their carrying values as of the fourth quarter of 2008. For additional information, see Critical Accounting Policies and Estimates and Note 10 to the Consolidated Financial Statements included in Item 8. Financial Statements and Supplemental Data. Other Income and Expense Interest Expense The following table provides the average daily borrowings and average borrowing rates for the fourth quarter of 2008 and 2007:
For the fourth quarter of 2008, our interest expense decreased $1 million to $45 million. The decrease was primarily driven by a decrease in average borrowings and average borrowing rates offset partially by an increase in fees related to our credit facilities. Interest Income For the fourth quarter of 2008, our interest income decreased $4 million to $2 million. The decrease was primarily driven by a decrease in average effective interest rates which was the result of our investment portfolio shift to U.S. government-backed securities. Other Income (Loss) For the fourth quarter of 2008, our other income decreased $10 million to $0. The decrease was primarily driven by lower income from our equity investment in Express. We divested 75% of our equity interest in Express in July 2007 and retained the remaining 25% as an equity method investment. Provision for Income Taxes For the fourth quarter of 2008, our effective tax rate increased to 85.4% from 34.2%. The increase in the rate resulted primarily from the impairment of goodwill and other intangible assets at La Senza, which is not deductible for income tax purposes.
14
Results of Operations – 2007 Compared to 2006 Operating Income The following table provides our segment operating income (loss) and operating income rates (expressed as a percentage of net sales) for 2007 in comparison to 2006:
For 2007, operating income decreased $66 million to $1.110 billion and the operating income rate remained flat at 11.0%. The drivers of the operating income results are discussed in the following sections. Net Sales The following table provides net sales for 2007 in comparison to 2006:
15
The following tables provide a reconciliation of net sales for 2006 to 2007:
The following table compares 2007 comparable store sales to 2006:
For 2007, our net sales decreased 5% to $10.134 billion and comparable store sales decreased 2%. The decrease in our net sales was primarily driven by the following: Victoria’s Secret For 2007, net sales increased 9% to $5.607 billion and comparable store sales decreased 2%. The increase in net sales was primarily driven by the inclusion of La Senza net sales for the full year in 2007. The decrease in comparable store sales was primarily driven by decreases across most categories, including core lingerie and beauty offset by modest increases in the Pink sub-brand and sleepwear. The decreases resulted from product assortment misses and a merchandise assortment that did not overcome the challenging economic environment in 2007. Bath & Body Works For 2007, net sales decreased 2% to $2.494 billion and comparable store sales decreased 4%. The decrease in net sales and comparable store sales was primarily driven by declines in store traffic experienced throughout the year and, in particular, during the fourth quarter which resulted in disappointing holiday and semi-annual sale performance. Apparel For 2007, net sales decreased 61% to $870 million as a result of the divestitures of Express and Limited Stores in the second quarter of 2007. Prior to the divestitures, comparable store sales increased 5%. Other For 2007, net sales increased by 58% to $1.163 billion primarily driven by an increase in third-party customer sales at Mast due to the divestitures of Express and Limited Stores during the second quarter of 2007. Subsequent to the divestitures, 75% of Mast sales to Express and Limited Stores are included in third-party customer sales while the remaining 25% are eliminated consistent with our ownership interest.
16
Gross Profit For 2007, our gross profit decreased 13% to $3.509 billion and our gross profit rate (expressed as a percentage of net sales) decreased to 34.6% from 37.6% primarily driven by the following: Victoria’s Secret For 2007, gross profit decreased primarily driven by the following:
Partially offset by:
The gross profit rate decreased driven primarily by deleverage of buying and occupancy expenses and a decline in the merchandise margin rate associated with promotional activities and markdowns on certain categories in response to soft sales trends. Bath & Body Works For 2007, gross profit decreased primarily driven by the decline in net sales. The gross profit rate decreased driven by a decline in the merchandise margin rate due to increased promotional activities designed to drive traffic. Apparel For 2007, gross profit decreased as a result of the divestitures of Express and Limited Stores in the second quarter of 2007. General, Administrative and Store Operating Expenses For 2007, our general, administrative and store operating expenses decreased 8% to $2.616 billion primarily driven by the Apparel divestiture, cost reductions realized in the second half of the year associated with our second quarter restructuring program and gains from the sale of corporate aircraft. These decreases were partially offset by the charges recognized primarily in the second quarter of 2007 related to the restructuring program, increased costs at Victoria’s Secret Direct related to the new distribution center and the inclusion of La Senza’s general, administrative and store operating expenses for the full year in 2007. The general, administrative and store operating expense rate decreased to 25.8% from 26.6% primarily driven by the net impact of the Apparel divestiture, including the recognition of Mast net sales to Express and Limited Stores. Other Income and Expenses Interest Expense The following table provides the average daily borrowings and average borrowing rates for 2007 and 2006:
For 2007, interest expense increased $47 million to $149 million. The increase was primarily driven by an increase in average borrowings and average borrowing rates resulting from the issuance of $1.0 billion of notes and borrowing an additional $250 million under our amended term loan during the second quarter of 2007. Interest Income For 2007, interest income decreased $7 million to $18 million. The decrease was primarily driven by a decrease in average invested cash balances. Other Income (Loss) For 2007, other income (loss) increased $131 million to $128 million. The increase was primarily driven by a $100 million gain related to a distribution from Easton Town Center, LLC (“ETC”), in which we have an equity investment, and income from our equity investment in Express. In July 2007, ETC refinanced its existing bank loan and distributed cash proceeds of $150 million to its members. As an ETC member, we received approximately $102 million of proceeds resulting in a $100 million gain after
17
reducing our ETC carrying value from $2 million to zero. In addition, we had a net gain of $17 million from the settlement of interest rate lock agreements. Provision for Income Taxes For 2007, our effective tax rate decreased to 36.4% from 38.5%. The decline in the rate is primarily due to the reversal of state net operating loss carryforward valuation allowances in conjunction with the Apparel divestitures in the second quarter of 2007, a decline in the Canadian federal tax rate, audit settlements and other items. Net Income (Loss) Attributable to Noncontrolling Interest For 2007, net loss attributable to noncontrolling interest increased $21 million to $22 million. Net income (loss) attributable to noncontrolling interest represents the proportional share of net income or losses of consolidated, less than wholly owned subsidiaries attributable to the noncontrolling investor. The increase relates to losses from a personal care joint venture acquired during the first quarter of 2007 and losses from an investment in an independent technology company focused on large multi-channel retailers. Results of Operations – Fourth Quarter of 2007 Compared to Fourth Quarter of 2006 Operating Income The following table provides our segment operating income (loss) and operating income rates (expressed as a percentage of net sales) for the fourth quarter of 2007 in comparison to the fourth quarter of 2006:
For the fourth quarter of 2007, operating income decreased $105 million to $621 million and the operating income rate increased to 19.0% from 18.1%. The drivers of the operating income results are discussed in the following sections.
18
Net Sales The following table provides net sales for the fourth quarter of 2007 in comparison to the fourth quarter of 2006:
The following table provides a reconciliation of net sales for the fourth quarter of 2006 to the fourth quarter of 2007:
The following table compares fourth quarter of 2007 comparable store sales to fourth quarter of 2006:
19
For the fourth quarter of 2007, our net sales decreased 19% to $3.276 billion and comparable store sales decreased 8%. The decrease in our net sales was primarily driven by the following: Victoria’s Secret For the fourth quarter of 2007, net sales increased 2% to $1.893 billion and comparable store sales decreased 8%. The increase in net sales was primarily driven by:
Offset partially by:
The decrease in comparable store sales was primarily driven by decreases across most categories, including core lingerie and beauty, offset by modest increases in the Pink sub-brand and sleepwear. The decreases resulted from product assortment misses and a merchandise assortment that did not overcome the challenging economic environment during the fourth quarter of 2007. Bath & Body Works For the fourth quarter of 2007, net sales decreased 8% to $1.080 billion and comparable store sales decreased 8%. The decrease in net sales was primarily driven by:
Other For the fourth quarter of 2007, net sales increased 25% to $303 million primarily driven by an increase in third-party customer sales at Mast due to the divestitures of Express and Limited Stores during the second quarter of 2007. Subsequent to the divestitures, 75% of Mast sales to Express and Limited Stores are included in third-party customer sales while the remaining 25% are eliminated in consolidation consistent with our ownership interest. Gross Profit For the fourth quarter of 2007, our gross profit decreased 20% to $1.296 billion and our gross profit rate (expressed as a percentage of net sales) decreased to 39.6% from 40.1% primarily driven by the following: Victoria’s Secret For the fourth quarter of 2007, gross profit decreased primarily driven by:
Offset partially by:
The gross profit rate decreased driven primarily by deleverage of buying and occupancy expenses due to the Victoria’s Secret Stores real estate expansion activities and inclusion of La Senza’s results for the full quarter in 2007. Bath & Body Works For the fourth quarter of 2007, gross profit decreased primarily driven by lower net sales. The gross profit rate decreased driven by a modest decline in the merchandise margin rate related to promotional activity to clear seasonal merchandise and deleverage in the buying and occupancy expense rate associated with the decline in net sales.
20
General, Administrative and Store Operating Expenses For the fourth quarter of 2007, our general, administrative and store operating expenses decreased 24% to $675 million primarily driven by the Apparel divestitures. The general, administrative and store operating expense rate decreased to 20.6% from 22.0% primarily driven by the net impact of the Apparel divestitures, including the recognition of Mast net sales to Express and Limited Stores. The rate also benefited from the initial recognition of gift card breakage at Victoria’s Secret and lower incentive compensation and marketing expense. Other Income and Expense Interest Expense The following table provides the average daily borrowings and average borrowing rates for the fourth quarter of 2007 and 2006:
For the fourth quarter of 2007, our interest expense increased $18 million to $46 million. The increase was primarily driven by an increase in average borrowings and average borrowing rates resulting from the issuance of $1.0 billion of notes and borrowing an additional $250 million under our amended term loan during the second quarter of 2007. Interest Income For the fourth quarter of 2007, our interest income increased $2 million to $6 million. The increase was primarily driven by an increase in average invested cash balances partially offset by a decrease in average effective interest rates. Other Income (Loss) For the fourth quarter of 2007, our other income (loss) increased $9 million to $10 million. The increase was primarily driven by income from our equity investment in Express. We divested 75% of Express in July 2007 and retained the remaining 25% as an equity method investment. Provision for Income Taxes For the fourth quarter of 2007, our effective tax rate decreased to 34.2% from 37.7%. The decline in the rate resulted from a decline in the Canadian federal tax rate, the finalization of income taxes related to the Apparel divestitures, audit settlements and other items.
21
FINANCIAL CONDITION Liquidity and Capital Resources Liquidity, or access to cash, is an important factor in determining our financial stability. We are committed to maintaining adequate liquidity. Cash generated from our operating activities provides the primary resources to support current operations, growth initiatives, seasonal funding requirements and capital expenditures. Our cash provided from operations is impacted by working capital changes and our net income. Our net income is impacted by, among other things, sales volume, seasonal sales patterns, timing of new product introductions and profit margins. Historically, sales are higher during the fourth quarter of the fiscal year due to seasonal and holiday-related sales patterns. Generally, our need for working capital peaks during the summer and fall months as inventory builds in anticipation of the holiday period. As of January 31, 2009, we had total revolving credit facilities of $1.3 billion including a $1 billion, 5-year facility that expires in August 2012 (the “5-Year Facility”) and a $300 million, 364-day facility that was set to expire in July 2009 (the “364-Day Facility”). The facilities contain fixed charge coverage and leverage covenants that may limit the availability of the facilities. Both facilities support our commercial paper and letter of credit programs. We did not borrow under either of the facilities in 2008. On February 19, 2009, we amended the 5-Year Facility and the $750 million term loan maturing in August 2012 (“Term Loan”) and we canceled the 364-Day Facility after determining it was no longer required. The amendment to the 5-Year Facility and the Term Loan includes changes to both the fixed charge coverage and leverage covenants which provide additional flexibility. Under the amended covenants, we are required to maintain the fixed charge coverage ratio at 1.60 or above through fiscal year 2010 and 1.75 or above thereafter. The leverage ratio, which is debt compared to EBITDA, as those terms are defined in the agreement, must not exceed 5.0 through the third quarter of fiscal year 2010, 4.5 from the fourth quarter of fiscal year 2010 through the third quarter of fiscal year 2011 and 4.0 thereafter. The amendment also increases the interest costs and fees associated with the 5-Year Facility and the Term Loan, provides for certain security interests as defined in the agreement and limits dividends, share repurchases and other restricted payments as defined in the agreement to $220 million per year with certain potential increases as defined in the agreement. The interest rate as of January 31, 2009 on the Term Loan would have been 6.69% had the amendment been effective at that date. The amendment does not impact the maturity dates of either the 5-Year Facility or the Term Loan. The U.S. retail sector and our business have faced a very difficult environment during most of 2008 and into 2009. However, we believe that available short-term and long-term capital resources are sufficient to fund foreseeable requirements. The following table provides a summary of our working capital position and capitalization as of January 31, 2009, February 2, 2008 and February 3, 2007:
22
The following table provides certain measures of liquidity and capital resources as of January 31, 2009, February 2, 2008 and February 3, 2007:
Credit Ratings The following table provides our credit ratings as of January 31, 2009:
Our borrowing costs and certain other provisions under our Term Loan and revolving credit facilities are linked to our credit ratings. As a result of the Moody’s and S&P downgrades, our borrowing costs under our term loan and revolving credit facilities increased in the fourth quarter of 2008. The impact of this increase was not material to our earnings and cash flows in the fourth quarter of 2008. The Moody’s or S&P downgrades did not accelerate the repayment of any of our debt. The following table provides an update of our credit ratings as of March 20, 2009:
The downgrades by the rating agencies in February 2009 will further increase our borrowing costs in 2009. If we receive an additional downgrade in our credit ratings by any agencies listed above, the availability of additional credit could be negatively affected. Credit rating downgrades by any of the agencies do not accelerate the repayment of any of our debt. Common Stock Share Repurchases In October 2008, our Board of Directors authorized management to repurchase $250 million of our outstanding common stock. During November 2008, we repurchased 5.0 million shares of our common stock for $43 million at an average price per share of approximately $8.64. Through March 20, 2009, no additional shares were repurchased. Dividend Policy and Procedures
23
We currently pay a common stock dividend of $0.15 per share in cash each quarter. Our Board of Directors will determine future dividends after giving consideration to our levels of profit and cash flow, capital requirements, current and forecasted liquidity, the restrictions placed upon us by our borrowing arrangements as well as financial and other business conditions existing at the time. Cash Flow The following table provides a summary of our cash flow activity for the fiscal years ended January 31, 2009, February 2, 2008 and February 3, 2007:
Operating Activities Net cash provided by operating activities in 2008 was $954 million. Net income of $216 million included (a) $343 million of depreciation and amortization, (b) a $215 million impairment of goodwill and other intangible assets and (c) a $109 million net gain on joint ventures. Other changes in assets and liabilities represent items that had a current period cash flow impact, such as changes in working capital. The most significant working capital change was a $103 million increase in operating cash flow associated with accounts receivable due primarily to reduced sourcing and other transition services billings to Express and Limited Stores. Net cash provided by operating activities in 2007 was $765 million consisting primarily of net income of $696 million. Net income included (a) $352 million of depreciation and amortization, (b) the $302 million gain on divestiture of Express, and (c) the $100 million gain on distribution from Easton Town Center, LLC. Other changes in assets and liabilities represent items that had a current period cash flow impact, such as changes in working capital. The most significant working capital change was a $337 million increase in operating cash flow associated with inventories. Inventory levels decreased compared to 2006 due to a concerted effort to control and reduce inventory levels across the enterprise and due to reductions in safety stocks at Bath & Body Works that increased during 2006 in connection with the 2006 supply chain system conversion. Accounts receivable increased due to the Apparel divestitures, which caused Mast’s accounts receivable from Express and Limited Stores to be recognized as third-party receivables on our balance sheet. Net cash provided by operating activities in 2006 was $600 million consisting primarily of net income of $675 million. Net income included $316 million of depreciation and amortization. Other changes in assets and liabilities represent items that had a current period cash flow impact, such as changes in working capital. The most significant working capital change was a $545 million decrease in operating cash flow associated with inventories. We increased inventory levels during the year to meet the following objectives: (a) at Victoria’s Secret, increases related to new product launches in core lingerie and beauty, initiatives to increase market share and build brand loyalty and an initiative to improve in-stock inventory positions and (b) at Bath & Body Works, increases related primarily to investments in safety stocks of seasonless basics in anticipation of the supply chain system conversion that occurred mid-year as well as an initiative to improve in-stock inventory positions. Investing Activities Net cash used for investing activities in 2008 was $240 million consisting primarily of $479 million of capital expenditures offset by $159 million from the divestiture of a joint venture and $95 million from returns of capital from Express. The capital expenditures included $345 million for opening new stores and remodeling and improving existing stores. Remaining capital expenditures were primarily related to spending on technology and infrastructure to support growth. Net cash provided by investing activities in 2007 was $30 million consisting primarily of (a) $547 million of proceeds from the divestiture of Express, (b) $102 million of proceeds from a distribution from Easton Town Center, LLC, and (c) $97 million of proceeds related to the sale of assets, offset by $749 million of capital expenditures. The capital expenditures included $476 million for opening new stores and remodeling and improving existing stores. Remaining capital expenditures were primarily related to investments in our new distribution center and increased spending on home office, technology and infrastructure.
24
Net cash used for investing activities in 2006 was $1.093 billion consisting primarily of $572 million related to the acquisition of La Senza and $548 million of capital expenditures. The capital expenditures included $311 million for opening new stores and remodeling and improving existing stores. Remaining capital expenditures were primarily related to investments in new growth concepts and increased spending on technology and infrastructure to support growth. We anticipate spending approximately $200 million for capital expenditures in 2009 with the majority relating to opening new stores and remodeling and improving existing stores. We expect to open approximately 50 new stores in the U.S. and Canada and to close approximately 70 stores. Our new stores will be primarily Bath & Body Works and Victoria’s Secret. Financing Activities Net cash used for financing activities in 2008 was $562 million consisting primarily of (a) cash payments of $379 million related to the repurchase of 28 million shares of common stock during the year at a weighted-average price of $13.36 under our November 2007 and October 2008 share repurchase programs and (b) quarterly dividend payments of $0.15 per share, or $201 million. These uses of cash were partially offset by the exercise of stock options of $31 million. Net cash used for financing activities in 2007 was $279 million consisting primarily of (a) cash payments of $1.4 billion related to the repurchase of 59 million shares of common stock during the year at a weighted-average price of $24.01 under our June 2006, June 2007, August 2007 and November 2007 share repurchase programs and (b) quarterly dividend payments of $0.15 per share, or $227 million. These uses of cash were partially offset by (a) debt offering proceeds of $997 million, (b) proceeds from the term loan refinancing of $250 million and (c) the exercise of stock options of $74 million. Net cash used for financing activities in 2006 was $215 million consisting primarily of (a) cash payments of $193 million related to the repurchase of 8 million shares of common stock during the year at a weighted-average price of $24.98 under our November 2005, February 2006 and June 2006 share repurchase programs and (b) quarterly dividend payments of $0.15 per share, or $238 million. These uses of cash were partially offset by proceeds from the exercise of stock options of $153 million and excess tax benefits on share-based compensation of $46 million. Contingent Liabilities and Contractual Obligations The following table provides our contractual obligations, aggregated by type, including the maturity profile as of January 31, 2009:
25
In connection with the disposition of certain businesses, we have remaining guarantees of approximately $194 million related to lease payments of Express, Limited Stores, Abercrombie & Fitch, Tween Brands (formerly Limited Too and Too, Inc.), Dick’s Sporting Goods (formerly Galyan’s), Lane Bryant, New York & Company and Anne.x under the current terms of noncancelable leases expiring at various dates through 2019. These guarantees include minimum rent and additional payments covering taxes, common area costs and certain other expenses and relate to leases that commenced prior to the disposition of the businesses. In certain instances, our guarantee may remain in effect if the term of a lease is extended. The following table details the guaranteed lease payments during the next five fiscal years and the remaining years thereafter:
In April 2008, we received an irrevocable standby letter of credit from Express of $34 million issued by a third-party bank to mitigate a portion of our contingent liability for guaranteed future lease payments of Express. We can draw from the irrevocable standby letter of credit if Express were to default on any of the guaranteed leases. The irrevocable standby letter of credit is reduced through September 30, 2010, the expiration date of the letter of credit, consistent with the overall reduction in guaranteed lease payments. The outstanding balance of the irrevocable standby letter of credit from Express was $19 million as of January 31, 2009. Our guarantees related to Express, Limited Stores and New York & Company are subject to the provisions of SFAS 145, Rescission, Amendment and Technical Correction of Certain Accounting Standards, which requires fair value accounting for these guarantee obligations. The guaranteed lease payments related to Express (net of the irrevocable standby letter of credit), Limited Stores and New York & Company totaled $94 million and $180 million as of January 31, 2009 and February 2, 2008, respectively. The estimated fair value of these guarantee obligations was $15 million and $10 million as of January 31, 2009 and February 2, 2008, respectively, and is included in Other Long-term Liabilities on our Consolidated Balance Sheets. The increase in the fair value from February 2, 2008 to January 31, 2009 reflects the impact of the current economic environment and our assessment of the risk of default on the guaranteed lease payments. Our guarantees related to Abercrombie & Fitch, Tween Brands (formerly Limited Too and Too, Inc.), Dick’s Sporting Goods (formerly Galyan’s), Lane Bryant and Anne.x are not subject to the fair value provisions of SFAS 145 because they were executed prior to the effective date of SFAS 145. These guarantees are subject to the provisions of SFAS 5, Accounting for Contingencies, which requires that a loss be accrued when probable and reasonably estimable. As of January 31, 2009 and February 2, 2008, we had no liability recorded with respect to any of the guarantee obligations subject to SFAS 5 as we concluded that performance under these guarantees was not probable. Off Balance Sheet Arrangements We have no off balance sheet arrangements as defined by Regulation 229.303 Item 303 (a) (4). Recently Issued Accounting Pronouncements SFAS 161, Disclosures about Derivative Instruments and Hedging Activities (“SFAS 161”) In March 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS 161, which requires disclosures about the fair value of derivative instruments and their gains or losses in tabular format as well as disclosures regarding credit-risk-related contingent features in derivative agreements, counterparty credit risk and strategies and objectives for using derivative instruments. SFAS 161 amends and expands SFAS 133, Accounting for Derivative Instruments and Hedging Activities, and is effective prospectively beginning in 2009. Adoption of SFAS 161 will impact our disclosures about derivative instruments and hedging activities beginning in 2009. SFAS 141, (revised 2007) Business Combinations (“SFAS 141(R)”)
26
In December 2007, the FASB issued SFAS 141(R), which establishes how the acquiring entity recognizes and measures the assets acquired, liabilities assumed, any gain on bargain purchases and any noncontrolling interest in the acquired entity. SFAS 141(R) requires acquisition-related costs to be expensed in the periods they are incurred, with the exception of the costs to issue debt or equity securities. SFAS 141(R) requires disclosure of information for a business combination that occurs during the accounting period or prior to the issuance of the financial statements for the accounting period. SFAS 141(R) is effective prospectively for business combinations with an acquisition date on or after the beginning of the first annual reporting period after December 15, 2008. Adoption of SFAS 141(R) is not expected to have an impact to our financial statements. SFAS 160, Noncontrolling Interests in Consolidated Financial Statements (“SFAS 160”) In December 2007, the FASB issued SFAS 160, which modifies reporting for noncontrolling interest (minority interest) in consolidated financial statements. SFAS 160 requires noncontrolling interest be reported in equity and establishes a new framework for recognizing net income or loss and comprehensive income by the controlling interest. SFAS 160 requires specific disclosures regarding changes in equity interest of both the controlling and noncontrolling parties and presentation of the noncontrolling equity balance and income or loss for all periods presented. SFAS 160 is effective for interim and annual periods in fiscal years beginning after December 15, 2008. Upon adoption, prior period financial statements were recast for the presentation of the noncontrolling interest consistent with the retrospective application required by SFAS 160. The impact of the retrospective application of this standard is as follows:
In addition, we adjusted references to these items in Item 6. Selected Financial Data and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”) In February 2007, the FASB issued SFAS 159 permitting entities to choose to measure many financial instruments and certain other items at fair value. The standard also establishes presentation and disclosure requirements designed to facilitate comparison between entities that choose different measurement attributes for similar types of assets and liabilities. If the fair value option is elected, the effect of the first remeasurement to fair value is reported as a cumulative effect adjustment to the opening balance of retained earnings. The statement is applied prospectively upon adoption. We did not adopt fair value treatment for any assets or liabilities under SFAS 159 as of the beginning of 2008. SFAS 157, Fair Value Measurements (“SFAS 157”) In September 2006, the FASB issued SFAS 157, which provides guidance for fair value measurement of assets and liabilities and instruments measured at fair value. The statement defines fair value, establishes a fair value measurement framework and expands fair value disclosures. It emphasizes that fair value is market-based with the highest measurement hierarchy level being market prices in active markets. The standard requires fair value measurements be disclosed by hierarchy level, an entity include its own credit standing in the measurement of its liabilities and modifies the transaction price presumption. In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement 157 which delays the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The provision of SFAS 157 is applied prospectively. We adopted the required portions of SFAS 157 at the beginning of 2008 which did not have a material impact to our financial statements. Adoption of the portions of SFAS 157 within the scope of FSP FAS 157-2 will not have a material impact on our financial statements beginning in 2009. Future Accounting Changes The FASB’s standard-setting process is ongoing and until new standards have been finalized and issued by FASB, we cannot determine the impact on the reporting of our operations and financial position that may result from any such future changes. The FASB is currently working on several projects including, but not limited to, revenue recognition, liabilities and equity, derivatives disclosures, earnings per share calculations and leases. We are also monitoring the potential adoption of International Financial Reporting Standards in the U.S. The ultimate pronouncements resulting from these and future projects could have an impact on our future results of operations and financial position.
27
Impact of Inflation While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on the results of operations and financial condition have been minor. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to adopt accounting policies related to estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements. On an ongoing basis, management evaluates its accounting policies, estimates and judgments, including those related to inventories, long-lived assets, claims and contingencies, income taxes and revenue recognition. Management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. Management has discussed the development and selection of its critical accounting policies and estimates with the Audit Committee of its Board of Directors and believes the following assumptions and estimates are most significant to reporting its results of operations and financial position. Inventories Inventories are principally valued at the lower of cost or market, on a weighted-average cost basis. We record valuation adjustments to our inventories if the cost of specific inventory items on hand exceeds the amount we expect to realize from the ultimate sale or disposal of the inventory. These estimates are based on management’s judgment regarding future demand and market conditions and analysis of historical experience. If actual demand or market conditions are different than those projected by management, future period merchandise margin rates may be unfavorably or favorably affected by adjustments to these estimates. We also record inventory loss adjustments for estimated physical inventory losses that have occurred since the date of the last physical inventory. These estimates are based on management’s analysis of historical results and operating trends. Management does not believe that the assumptions used in these estimates will change significantly based on prior experience. A 10% increase or decrease in the inventory valuation adjustment would have impacted net income by approximately $6 million for 2008. A 10% increase or decrease in the estimated physical inventory loss adjustment would have impacted net income by approximately $2 million for 2008. Valuation of Long-lived Assets Property and equipment and intangible assets with finite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the estimated undiscounted future cash flows related to the asset are less than the carrying value, we recognize a loss equal to the difference between the carrying value and the fair value, usually determined by the estimated discounted future cash flows of the asset. Factors used in the valuation include, but are not limited to, management’s plans for future operations, brand initiatives, recent operating results and projected future cash flows. When a decision has been made to dispose of property and equipment prior to the end of the previously estimated useful life, depreciation estimates are revised to reflect the use of the asset over the shortened estimated useful life. Goodwill is reviewed for impairment each year in the fourth quarter and may be reviewed more frequently if certain events occur or circumstances change. The impairment review is performed by comparing each reporting unit’s carrying value to its estimated fair value, determined through either estimated discounted future cash flows or market-based methodologies. If the carrying value exceeds the estimated fair value, we determine the fair value of all assets and liabilities of the reporting unit, including the implied fair value of goodwill. If the carrying value of goodwill exceeds the implied fair value, we recognize an impairment charge equal to the difference. Intangible assets with indefinite lives are reviewed for impairment each year in the fourth quarter and may be reviewed more frequently if certain events occur or circumstances change. The impairment review is performed by comparing the carrying value to the estimated fair value, usually determined using a discounted cash flow methodology. Factors used in the valuation of goodwill and intangible assets include, but are not limited to, management’s plans for future operations, brand initiatives, recent operating results and projected future cash flows. If future economic conditions are different than those projected by management, future impairment charges may be required. Impairment of La Senza Goodwill and Indefinite Lived Intangible Assets
28
In conjunction with the January 2007 acquisition of La Senza, we recorded $313 million in goodwill and $170 million in trade name intangible assets. These assets are included in the La Senza reporting unit which is part of the Victoria’s Secret segment. In the fourth quarter of 2008, we completed our annual impairment testing under SFAS 142, Goodwill and Other Intangible Assets (“SFAS 142”). We concluded that goodwill and certain trade name assets related to the La Senza acquisition were impaired. We recorded impairment charges of $189 million and $26 million related to the goodwill and trade name assets, respectively. These impairment charges are included in Impairment of Goodwill and Other Intangible Assets on the 2008 Consolidated Statement of Income. The estimated fair values of our other reporting units exceeded their respective carrying values as of the fourth quarter of 2008. Accordingly, no goodwill impairment charges were recorded for these reporting units. Reasonable changes in the significant estimates and assumptions used to determine these fair values would not have resulted in goodwill impairments in any of these reporting units. If economic conditions in 2009 and beyond continue to deteriorate, future impairment charges may be required. Impairment Indicators The primary impairment indicator associated with the impairment charge was the deterioration in La Senza’s operating results during the latter half of 2008, particularly when compared to our expectations at the time of the acquisition. La Senza’s operating results were negatively impacted by the global economic downturn and the resulting impact on the Canadian retail environment. Impairment Testing We evaluated La Senza’s goodwill by comparing the carrying value of the La Senza reporting unit to the estimated fair value of the reporting unit derived using a discounted cash flow methodology. We corroborated the estimated fair value of the La Senza reporting unit as determined by our discounted cash flow approach by referencing a market-based methodology. Based on our evaluation, the carrying value of the La Senza reporting unit exceeded the estimated fair value. As a result, we measured the goodwill impairment in accordance with the provisions of SFAS 142 by comparing the carrying value of the reporting unit’s goodwill to the implied value of the goodwill based on the estimated fair value of the reporting unit, considering the fair value of all assets and liabilities. As a result of this analysis, we recognized a goodwill impairment charge of $189 million. We evaluated the La Senza trade name assets by comparing the carrying value to the estimated fair value determined using a relief from royalty methodology. Based on our evaluation, the carrying value of certain La Senza trade name assets exceeded their estimated fair value and, as a result, we recognized impairment charges totaling $26 million to reduce the carrying values to their estimated fair values. Significant Estimates and Assumptions The discounted cash flow models used to estimate the applicable fair values involve numerous estimates and assumptions that are highly subjective. Changes to these estimates and assumptions could materially impact the fair value estimates. The estimates and assumptions critical to the overall fair value estimates include: (i) estimated future cash flow generated by La Senza; (ii) discount rates used to derive the present value factors used in determining the fair values; and (iii) the terminal value assumption used in the discounted cash flow methodologies. These and other estimates and assumptions are impacted by economic conditions and expectations of management and may change in the future based on period-specific facts and circumstances. If economic conditions in 2009 and beyond continue to deteriorate, future impairment charges may be required. Sensitivity Analysis Our determination of the estimated fair value of the La Senza reporting unit and trade name assets requires significant judgment about economic factors, industry factors, as well as our views regarding the future prospects of the La Senza reporting unit. Changes in these judgments may have a significant effect on the estimated fair value of La Senza’s goodwill and trade name assets. The following provides sensitivities related to the significant estimates and assumptions as noted above:
29
Claims and Contingencies We are subject to various claims and contingencies related to lawsuits, insurance, regulatory and other matters arising out of the normal course of business. Our determination of the treatment of claims and contingencies in the Consolidated Financial Statements is based on management’s view of the expected outcome of the applicable claim or contingency. We consult with legal counsel on matters related to litigation and seek input from both internal and external experts within and outside our organization with respect to matters in the ordinary course of business. We accrue a liability if the likelihood of an adverse outcome is probable and the amount is estimable. If the likelihood of an adverse outcome is only reasonably possible (as opposed to probable), or if an estimate is not determinable, disclosure of a material claim or contingency is disclosed in the Notes to the Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data. Income Taxes We account for income taxes under the asset and liability method. Under this method, the amount of taxes currently payable or refundable are accrued and deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are also recognized for realizable operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted income tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in income tax rates is recognized in our Consolidated Statement of Income in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if it is more likely than not that such assets will not be realized. Significant judgment is required in determining the provision for income taxes and related accruals, deferred tax assets and liabilities. In determining our provision for income taxes, we use an annual effective income tax rate based on annual income, permanent differences between book and tax income and statutory income tax rates. We adjust the annual effective income tax rate as additional information on outcomes or events becomes available. Our effective income tax rate is affected by items including changes in tax law, the tax jurisdiction of new stores or business ventures and the level of earnings. Effective February 4, 2007, we adopted FASB Interpretation 48 (“FIN 48”) and FASB Staff Position (“FSP”) FIN 48-1, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement 109. FIN 48 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS 109, Accounting for Income Taxes. The first step is to evaluate the tax position for recognition by determining if the available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately forecast actual outcomes. Our policy is to include interest and penalties related to uncertain tax positions in income tax expense. Our income tax returns, like those of most companies, are periodically audited by domestic and foreign tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any one time, multiple tax years are subject to audit by the various tax authorities. We record an accrual for more likely than not exposures after evaluating the positions associated with our various income tax filings. A number of years may elapse before a particular matter for which we have established an accrual is audited and fully resolved or clarified. We adjust our tax contingencies accrual and income tax provision in the period in which matters are effectively settled with tax authorities at amounts different from our established accrual when the statute of limitations expires for the relevant taxing authority to examine the tax position or when more information becomes available. Although we believe that our estimates are reasonable, actual results could differ from these estimates resulting in a final tax outcome that may be materially different from that which is reflected in our Consolidated Financial Statements. Revenue Recognition While our recognition of revenue does not involve significant judgment, revenue recognition represents an important accounting policy for our organization. We recognize revenue upon customer receipt of the merchandise. For direct response revenues, we estimate shipments that have not been received by the customer based on shipping terms and historical delivery times. We also provide a reserve for projected merchandise returns based on prior experience. All of our brands sell gift cards with no expiration dates to customers in retail stores, through our direct channels and through third parties. We do not charge administrative fees on unused gift cards. We recognize income from gift cards when they are redeemed by the customer. In addition, we recognize income on unredeemed gift cards when we can determine that the likelihood of the gift card being redeemed is remote and there is no legal obligation to remit the unredeemed gift cards to relevant jurisdictions (gift card breakage). We determine the gift card breakage rate based on historical redemption patterns. We accumulated sufficient historical
30
data to determine the gift card breakage rate at Bath & Body Works and Express during the fourth quarter of 2005 and Victoria’s Secret during the fourth quarter of 2007. Gift card breakage is included in Net Sales in our Consolidated Statements of Income. During the fourth quarter of 2005, we recognized $30 million in pre-tax income related to the initial recognition of gift card breakage at Express and Bath & Body Works. During the fourth quarter of 2007, we recognized $48 million in pre-tax income related to the initial recognition of gift card breakage at Victoria’s Secret. Additionally, we recognize revenue associated with merchandise sourcing services provided to third parties, consisting primarily of former subsidiaries as well as other third parties. Revenue is recognized at the time the title passes to the customer.
31
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995 We caution that any forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained in this report or made by our company or our management involve risks and uncertainties and are subject to change based on various important factors, many of which are beyond our control. Accordingly, our future performance and financial results may differ materially from those expressed or implied in any such forward-looking statements. Words such as “estimate,” “project,” “plan,” “believe,” “expect,” “anticipate,” “intend,” “planned,” “potential” and similar expressions may identify forward-looking statements. Risks associated with the following factors, among others, in some cases have affected and in the future could affect our financial performance and actual results and could cause actual results to differ materially from those expressed or implied in any forward-looking statements included in this report or otherwise made by our company or our management:
We are not under any obligation and do not intend to make publicly available any update or other revisions to any of the forward-looking statements contained in this report to reflect circumstances existing after the date of this report or to reflect the occurrence of future events even if experience or future events make it clear that any expected results expressed or implied by those forward-looking statements will not be realized.
32
LIMITED BRANDS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Our fiscal year ends on the Saturday closest to January 31. Fiscal years are designated in the Consolidated Financial Statements and Notes by the calendar year in which the fiscal year commences. The results for fiscal years 2008 and 2007 represent the 52 week period ending January 31, 2009 and February 2, 2008, respectively, and 2006 refers to the 53 week period ended February 3, 2007.
33
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements To the Board of Directors and Shareholders of Limited Brands, Inc.: We have audited the accompanying Consolidated Balance Sheets of Limited Brands, Inc. and subsidiaries as of January 31, 2009 and February 2, 2008, and the related Consolidated Statements of Income, Total Equity, and Cash Flows for each of the three years in the period ended January 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Limited Brands, Inc. and subsidiaries at January 31, 2009 and February 2, 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended January 31, 2009, in conformity with U.S. generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, the accompanying consolidated financial statements have been retrospectively adjusted for the adoption of Financial Accounting Standards Board (“FASB”) Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (SFAS 160). Also as discussed in Note 2 to the consolidated financial statements, in 2007 the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”, and in 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (R), “Share-Based Payment.” We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Limited Brands, Inc. and subsidiaries’ internal control over financial reporting as of January 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 27, 2009 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP March 27, 2009, except for the effects of the adoption of SFAS 160 and related disclosures in Notes 1, 2, and 10 as to which the date is June 12, 2009
34
LIMITED BRANDS, INC. CONSOLIDATED STATEMENTS OF INCOME (in millions except per share amounts)
The accompanying Notes are an integral part of these Consolidated Financial Statements.
35
LIMITED BRANDS, INC. CONSOLIDATED BALANCE SHEETS (in millions except per share amounts)
The accompanying Notes are an integral part of these Consolidated Financial Statements.
36
LIMITED BRANDS, INC. CONSOLIDATED STATEMENTS OF TOTAL EQUITY (in millions except per share amounts)
The accompanying Notes are an integral part of these Consolidated Financial Statements.
37
LIMITED BRANDS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in millions)
The accompanying Notes are an integral part of these Consolidated Financial Statements.
38
LIMITED BRANDS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Description of Business and Summary of Significant Accounting Policies Description of Business Limited Brands, Inc. (the Company) operates in the highly competitive specialty retail business. The Company is a specialty retailer of women's intimate and other apparel, beauty and personal care products and accessories. The Company sells its merchandise through specialty retail stores in the United States and Canada, which are primarily mall-based, and through its websites and catalogue. The Company currently operates the following retail brands:
Basis of Consolidation The Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The Consolidated Financial Statements include the results of Express and Limited Stores through their divestiture dates which were July 6, 2007 and August 3, 2007, respectively. Subsequent to the divestitures of Express and Limited Stores, the Company’s remaining 25% ownership interest in each is accounted for under the equity method of accounting. The Company eliminates in consolidation 25% of sourcing sales to Express and Limited Stores consistent with the Company’s ownership percentage. The Company’s Consolidated Financial Statements also include less than 100% owned variable interest entities in which the Company is designated as the primary beneficiary in accordance with Financial Accounting Standards Board Interpretation 46(R), Consolidation of Variable Interest Entities, (“FIN 46(R)”). The Company accounts for investments in unconsolidated entities where it exercises significant influence, but does not have control, using the equity method of accounting. Under the equity method of accounting, the Company recognizes its share of the investee net income or loss. Losses are only recognized to the extent the Company has positive carrying value related to the investee. Carrying values are only reduced below zero if the Company has an obligation to provide funding to the investee. The Company’s share of net income or loss of unconsolidated entities from which the Company purchases merchandise or merchandise components is included in Cost of Goods Sold, Buying and Occupancy on the Consolidated Statements of Income. The Company’s share of net income or loss of all other unconsolidated entities is included in Other Income (Loss) on the Consolidated Statements of Income. The Company’s equity investments are required to be tested for impairment when it is determined there may be an other than temporary loss in value. Fiscal Year The Company’s fiscal year ends on the Saturday nearest to January 31. As used herein, “2008” and “2007” refer to the 52-week periods ending January 31, 2009 and February 2, 2008, respectively. “2006” refers to the 53-week period ended February 3, 2007. Cash and Cash Equivalents Cash and Cash Equivalents include cash on hand, demand deposits with financial institutions and highly liquid investments with original maturities of less than 90 days. The Company’s outstanding checks, which amounted to $86 million as of January 31, 2009 and $121 million as of February 2, 2008, are included in Accounts Payable on the Consolidated Balance Sheets. Concentration of Credit Risk The Company maintains cash and cash equivalents with various major financial institutions, as well as corporate commercial paper from time to time. Currently, the Company’s investment portfolio is comprised primarily of U.S. government-backed securities.
39
The Company monitors the relative credit standing of financial institutions and other entities with whom the Company transacts and limits the amount of credit exposure with any one entity. The Company also monitors the creditworthiness of entities to which the Company grants credit terms in the normal course of business and counterparties to derivative instruments. Inventories Inventories are principally valued at the lower of cost or market, on a weighted-average cost basis. The Company records valuation adjustments to its inventories if the cost of specific inventory items on hand exceeds the amount it expects to realize from the ultimate sale or disposal of the inventory. These estimates are based on management’s judgment regarding future demand and market conditions and analysis of historical experience. The Company also records inventory loss adjustments for estimated physical inventory losses that have occurred since the date of the last physical inventory. These estimates are based on management’s analysis of historical results and operating trends. Catalogue and Advertising Costs The Company capitalizes the direct costs of producing and distributing its catalogues and amortizes the costs over the expected future revenue stream, which is generally three months from the date the catalogues are mailed. The Company’s capitalized direct response advertising costs amounted to $27 million and $33 million as of January 31, 2009 and February 2, 2008, respectively, and are included in Other Current Assets on the Consolidated Balance Sheets. All other advertising costs are expensed at the time the promotion first appears in media or in the store. Catalogue and advertising costs amounted to $502 million for 2008, $507 million for 2007 and $594 million for 2006. Property and Equipment The Company’s property and equipment are recorded at cost and depreciation/amortization is computed on a straight-line basis using the following depreciable life ranges:
When a decision has been made to dispose of property and equipment prior to the end of the previously estimated useful life, depreciation estimates are revised to reflect the use of the asset over the shortened estimated useful life. The Company’s cost of assets sold or retired and the related accumulated depreciation are removed from the accounts with any resulting gain or loss included in net income. Maintenance and repairs are charged to expense as incurred. Major renewals and betterments that extend useful lives are capitalized. Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the estimated undiscounted future cash flows related to the asset are less than the carrying value, the Company recognizes a loss equal to the difference between the carrying value and the estimated fair value, usually determined by the estimated discounted future cash flows of the asset. Factors used in the valuation include, but are not limited to, management’s plans for future operations, brand initiatives, recent operating results and projected future cash flows. Goodwill and Intangible Assets The Company has certain intangible assets resulting from business combinations that are recorded at cost. Intangible assets with finite lives are amortized primarily on a straight-line basis over their respective estimated useful lives ranging from 3 to 20 years. Intangible assets with finite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the estimated undiscounted future cash flows related to the asset are less than the carrying value, the Company recognizes a loss equal to the difference between the carrying value and the estimated fair value, usually determined by the estimated discounted future cash flows of the asset. Factors used in the valuation include, but are not limited to, management’s plans for future operations, brand initiatives, recent operating results and projected future cash flows. Goodwill represents the excess of the purchase price over the fair value of the net assets acquired. Goodwill is not subject to periodic amortization. Goodwill is reviewed for impairment each year in the fourth quarter and may be reviewed more frequently if certain events occur or circumstances change. The impairment review is performed by comparing each reporting unit’s carrying
40
value to its estimated fair value, determined through either estimated discounted future cash flows or market-based methodologies. If the carrying value exceeds the estimated fair value, the Company determines the fair value of all assets and liabilities of the reporting unit, including the implied fair value of goodwill. If the carrying value of goodwill exceeds the implied fair value, the Company recognizes an impairment charge equal to the difference. Intangible assets with indefinite lives are reviewed for impairment each year in the fourth quarter and may be reviewed more frequently if certain events occur or circumstances change. The impairment review is performed by comparing the carrying value to the estimated fair value, usually determined using a discounted cash flow methodology. Factors used in the valuation of goodwill and intangible assets include, but are not limited to, management’s plans for future operations, brand initiatives, recent operating results and projected future cash flows. If future economic conditions are different than those projected by management, future impairment charges may be required. Leases and Leasehold Improvements The Company has leases that contain predetermined fixed escalations of minimum rentals and/or rent abatements subsequent to taking possession of the leased property. The Company recognizes the related rent expense on a straight-line basis commencing upon store possession date. The Company records the difference between the recognized rental expense and amounts payable under the leases as deferred lease credits. The Company’s liability for predetermined fixed escalations of minimum rentals and/or rent abatements amounted to $90 million as of January 31, 2009 and $77 million as of February 2, 2008. These liabilities are included in Other Long-term Liabilities on the Consolidated Balance Sheets. The Company receives allowances from landlords related to its retail stores. These allowances are generally comprised of cash amounts received by the Company from its landlords as part of the negotiated lease terms. The Company records a receivable and a landlord allowance at the lease commencement date (date of initial possession of the store). The deferred lease credit is amortized on a straight-line basis as a reduction of rent expense over the term of the lease (including the pre-opening build-out period) and the receivable is reduced as amounts are received from the landlord. The Company’s unamortized portion of landlord allowances, which amounted to $224 million as of January 31, 2009 and $185 million as of February 2, 2008, is included in Other Long-term Liabilities on the Consolidated Balance Sheets. The Company also has leasehold improvements which are amortized over the shorter of their estimated useful lives or the period from the date the assets are placed in service to the end of the initial lease term. Leasehold improvements made after the inception of the initial lease term are depreciated over the shorter of their estimated useful lives or the remaining lease term, including renewal periods, if reasonably assured. Foreign Currency Translation The functional currency of the Company’s foreign operations is generally the applicable local currency. Assets and liabilities are translated into U.S. dollars using the current exchange rates in effect as of the balance sheet date, while revenues and expenses are translated at the average exchange rates for the period. The Company’s resulting translation adjustments are recorded as a component of Accumulated Other Comprehensive Income (Loss) within the Consolidated Statements of Shareholders’ Equity. Derivative Financial Instruments The Company uses derivative financial instruments to manage exposure to foreign currency exchange rates and interest rates. The Company does not use derivative financial instruments for trading purposes. Derivative financial instruments are accounted for in accordance with SFAS 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”) as amended, which requires that all derivative instruments be recorded on the Consolidated Balance Sheets at fair value. Income Taxes The Company accounts for income taxes under the asset and liability method. Under this method, the amount of taxes currently payable or refundable are accrued and deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are also recognized for realizable operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted income tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in income tax rates is recognized in the Company’s Consolidated Statement of Income in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if it is more likely than not that such assets will not be realized. In determining the Company’s provision for income taxes, it uses an annual effective income tax rate based on annual income, permanent differences between book and tax income and statutory income tax rates. The Company adjusts the annual effective
41
income tax rate as additional information on outcomes or events becomes available. The Company’s effective income tax rate is affected by items including changes in tax law, the tax jurisdiction of new stores or business ventures and the level of earnings. Effective February 4, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation 48 (“FIN 48”) and FASB Staff Position (“FSP”) FIN 48-1, Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109. FIN 48 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS 109, Accounting for Income Taxes. The first step is to evaluate the tax position for recognition by determining if the available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately forecast actual outcomes. The Company’s income tax returns, like those of most companies, are periodically audited by domestic and foreign tax authorities. These audits include questions regarding the Company’s tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any one time, multiple tax years are subject to audit by the various tax authorities. The Company records an accrual for more likely than not exposures after evaluating the positions associated with its various income tax filings. A number of years may elapse before a particular matter for which the Company has established an accrual is audited and fully resolved or clarified. The Company adjusts its tax contingencies accrual and income tax provision in the period in which matters are effectively settled with tax authorities at amounts different from its established accrual, when the statute of limitations expires for the relevant taxing authority to examine the tax position or when more information becomes available. The Company includes its tax contingencies accrual, including accrued penalties and interest, in Other Long-term Liabilities on the Consolidated Balance Sheets unless the liability is expected to be paid within one year. Changes to the tax contingencies accrual, including accrued penalties and interest, are included in Provision for Income Taxes on the Consolidated Statements of Income. Self Insurance The Company is self-insured for medical, workers’ compensation, property, general liability and automobile liability up to certain stop-loss limits. Such costs are accrued based on known claims and an estimate of incurred but not reported (“IBNR”) claims. IBNR claims are estimated using historical claim information and actuarial estimates. Noncontrolling Interest Noncontrolling interest represents the portion of equity interests of consolidated affiliates not owned by the Company. Share-based Compensation The Company accounts for share-based employee compensation in accordance with SFAS 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) requires all share-based payments to employees and directors to be recognized in the financial statements as compensation cost over the service period based on their estimated fair value on the date of grant. Compensation cost is recognized over the service period on a straight-line basis for the fair value of awards that actually vest. Compensation expense for stock options is recognized, net of forfeitures, using a single option approach (each option is valued as one grant, irrespective of the number of vesting tranches). Compensation cost for restricted stock is recognized, net of forfeitures, on a straight-line basis over the requisite service period. The Company has a policy of issuing treasury shares to satisfy award exercises or conversions. Revenue Recognition The Company recognizes sales upon customer receipt of the merchandise, which for direct response revenues reflects an estimate of shipments that have not yet been received by the customer based on shipping terms and estimated delivery times. The Company’s shipping and handling revenues are included in Net Sales with the related costs included in Costs of Goods Sold, Buying and Occupancy on the Consolidated Statements of Income. The Company also provides a reserve for projected merchandise returns based on prior experience. Net Sales exclude sales tax collected from customers. The Company’s brands sell gift cards with no expiration dates to customers. The Company does not charge administrative fees on unused gift cards. The Company recognizes income from gift cards when they are redeemed by the customer. In addition, the Company recognizes income on unredeemed gift cards when it can determine that the likelihood of the gift card being redeemed is remote and that there is no legal obligation to remit the unredeemed gift cards to relevant jurisdictions (gift card breakage). The Company determines the gift card breakage rate based on historical redemption patterns. The Company accumulated enough historical data to determine the gift card breakage rate at Bath & Body Works during the fourth quarter of 2005 and Victoria’s Secret during the fourth quarter of 2007. Gift card breakage is included in Net Sales in the Consolidated Statements of Income.
42
During the fourth quarter of 2007, the Company recognized $48 million in pre-tax income related to the initial recognition of gift card breakage at Victoria’s Secret. Additionally, the Company recognizes revenue associated with merchandise sourcing services provided to third parties, consisting of former subsidiaries as well as other third parties. Revenue is recognized at the time the title passes to the customer. Costs of Goods Sold, Buying and Occupancy The Company’s costs of goods sold include merchandise costs, net of discounts and allowances, freight and inventory shrinkage. The Company’s buying and occupancy expenses primarily include payroll, benefit costs and operating expenses for its buying departments and distribution network, rent, common area maintenance, real estate taxes, utilities, maintenance, catalogue amortization and depreciation for the Company’s stores, warehouse facilities and equipment. General, Administrative and Store Operating Expenses The Company’s general, administrative and store operating expenses primarily include payroll and benefit costs for its store-selling and administrative departments (including corporate functions), marketing, advertising and other operating expenses not specifically categorized elsewhere in the Consolidated Statements of Income. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements. Actual results may differ from those estimates and the Company revises its estimates and assumptions as new information becomes available. Reclassifications Certain prior period amounts have been reclassified to conform to the current period presentation. 2. New Accounting Pronouncements and Changes in Accounting Principle New Accounting Pronouncements SFAS 161, Disclosures about Derivative Instruments and Hedging Activities (“SFAS 161”) In March 2008, the FASB issued SFAS 161, which requires disclosures about the fair value of derivative instruments and their gains or losses in tabular format as well as disclosures regarding credit-risk-related contingent features in derivative agreements, counterparty credit risk and strategies and objectives for using derivative instruments. SFAS 161 amends and expands SFAS 133 and is effective prospectively beginning in 2009. Adoption of SFAS 161 will impact the Company’s disclosures about derivative instruments and hedging activities beginning in 2009. SFAS 141 (revised 2007), Business Combinations (“SFAS 141(R)”) In December 2007, the FASB issued SFAS 141(R), which establishes how the acquiring entity recognizes and measures the assets acquired, liabilities assumed, any gain on bargain purchases and any noncontrolling interest in the acquired entity. SFAS 141(R) requires acquisition-related costs to be expensed in the periods they are incurred, with the exception of the costs to issue debt or equity securities. SFAS 141(R) requires disclosure of information for a business combination that occurs during the accounting period or prior to the issuance of the financial statements for the accounting period. SFAS 141(R) is effective prospectively for business combinations with an acquisition date on or after the beginning of the first annual reporting period after December 15, 2008. Adoption of SFAS 141(R) is not expected to have an impact to the Company’s financial statements.
43
SFAS 160, Noncontrolling Interests in Consolidated Financial Statements (“SFAS 160”) In December 2007, the FASB issued SFAS 160, which modifies reporting for noncontrolling interest (minority interest) in consolidated financial statements. SFAS 160 requires noncontrolling interest be reported in equity and establishes a new framework for recognizing net income or loss and comprehensive income by the controlling interest. SFAS 160 requires specific disclosures regarding changes in equity interest of both the controlling and noncontrolling parties and presentation of the noncontrolling equity balance and income or loss for all periods presented. SFAS 160 is effective for interim and annual periods in fiscal years beginning after December 15, 2008. Upon adoption, prior period financial statements were recast for the presentation of the noncontrolling interest consistent with the retrospective application required by SFAS 160. The impact of the retrospective application of this standard is as follows:
In addition, the Company adjusted references to these items in the notes to the Company’s consolidated financial statements. SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”) In February 2007, the FASB issued SFAS 159 permitting entities to choose to measure many financial instruments and certain other items at fair value. The standard also establishes presentation and disclosure requirements designed to facilitate comparison between entities that choose different measurement attributes for similar types of assets and liabilities. If the fair value option is elected, the effect of the first remeasurement to fair value is reported as a cumulative effect adjustment to the opening balance of retained earnings. The statement is applied prospectively upon adoption. The Company did not adopt fair value treatment for any assets or liabilities under SFAS 159 as of the beginning of 2008. SFAS 157, Fair Value Measurements (“SFAS 157”) In September 2006, the FASB issued SFAS 157, which provides guidance for fair value measurement of assets and liabilities and instruments measured at fair value that are classified in shareholders’ equity. The statement defines fair value, establishes a fair value measurement framework and expands fair value disclosures. It emphasizes that fair value is market-based with the highest measurement hierarchy level being market prices in active markets. The standard requires fair value measurements be disclosed by hierarchy level, an entity include its own credit standing in the measurement of its liabilities and modifies the transaction price presumption. In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement 157, which delays the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Accordingly, as of February 3, 2008, the Company adopted SFAS 157 for financial assets and liabilities only. As of January 31, 2009, the Company’s financial assets and liabilities subject to SFAS 157 consisted of the cross-currency interest rate swaps and the participating interest rate swap. The fair value of these instruments is determined using valuation methodologies that employ Level 2 inputs as defined in SFAS 157. The adoption of SFAS 157 for financial assets and financial liabilities did not have a significant impact on the Company’s results of operations, financial condition or liquidity. Adoption of portions of SFAS 157 within the scope of FSP FAS 157-2 is not expected to have a material impact on the Company’s financial statements beginning in 2009. Changes in Accounting Principle Income Taxes Effective February 4, 2007, the Company adopted FIN 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), an interpretation of FASB Statement 109. Upon adoption, the Company recognized an additional $10 million liability for unrecognized tax benefits, which was accounted for as a reduction to the Company’s opening balance of retained earnings on February 4, 2007. For additional information, see Note 13, “Income Taxes.” Share-based Compensation
44
On January 29, 2006, the Company adopted SFAS 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”), which requires the measurement and recognition of compensation expense for all share-based awards made to employees and directors based on estimated fair values on the grant date. Prior to the adoption of SFAS 123(R), the Company accounted for share-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees (“APB 25”). Under the intrinsic value method, no stock-based compensation expense was recognized in the Company’s Consolidated Statements of Income, other than for restricted stock, because the exercise price of the Company’s stock options granted to employees and directors was equal to the estimated fair market value of the underlying stock at the date of grant. The Company adopted SFAS 123(R) using the modified prospective transition method, which required the application of the accounting standard as of January 29, 2006, the first day of the Company’s fiscal year 2006. Share-based compensation expense recognized in the Consolidated Statements of Income under SFAS 123(R) is based on awards ultimately expected to vest and, accordingly, has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The cumulative effect of change in accounting principle on the Consolidated Statement of Income for the year ended February 3, 2007 of $0.7 million (net of tax of $0.4 million) relates to an estimate of forfeitures of previously recognized unvested restricted stock awards outstanding as of January 29, 2006, the date of adoption of SFAS 123(R). 3. Earnings Per Share Earnings per basic share is computed based on the weighted-average number of outstanding common shares. Earnings per diluted share include the weighted-average effect of dilutive options and restricted stock on the weighted-average shares outstanding. The following table provides shares utilized for the calculation of basic and diluted earnings per share for 2008, 2007 and 2006:
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||